Question

. Using the IS-MP model in a closed economy, explain the impact of tax cuts on the interest rate (r) and output (y), indicating the multiplier effect and crowding-out effect on the graph

Answer 1

Is-mp model is indicatiing investment saving and monetary policy trends and their relationship in an economy. It is a macroeconomic tool which displays short term changes and trends in in interest rates, inflation and output in an Economy.

If tax cut then saving increase which may increase investment and thus it may led to increase production or output of gdp. Tax may increase inflation as money supply increase in the economy. It will led to decrease interest rate as money supply increaseincrease, investment increase and also employment generation in the economy.

Multiplier effect will be seen as increase money supply will increase investment and this created jobs which again increase saving and investment and thus this situation led to overall aggregate demand bor output increase in the economy.

Crowding out effect is there as taxes cut may increase money supply fir private investor also and thus private investment will increase and this led to crowding reduce crowding in .effect.

As aggregate demand curve shifts to right show increased money supply and thus increasing private investment , which is against the crowding out as government spending or money supply will be same or decrease in such situation as cimpare to before.